Composing New Product Development Portfolios with Internal and External Projects

Abstract

The process of building portfolios with competing internal and external new product development (NPD) projects-a key task for NPD portfolio managers in many innovation-driven industries-comprises two daunting challenges: (i) the collection of relevant information about the projects under consideration and (ii) the selection of the most promising projects under uncertainty. In order to create optimal NPD portfolios, firms must implement project selection policies that carefully control the tensions that arise between these two challenges. Most notably, installing a higher level of project selection flexibility allows firms to better select projects based on the information they obtain; however, greater selection flexibility also induces fiercer competition for resources among the projects, which undermines the reliability of a firm's information acquisition efforts and thus harms the quality of its selection decisions. Hence, we ask the following question: Which project selection policies can best align a firm's (ex ante) information acquisition efforts with its (ex post) project selection decisions when the firm contemplates investing in competing internal and external NPD projects? We study this question by developing a principal-multiagent model, and we derive the key properties of a firm's optimal project selection policy. We also identify different contingencies that chiefly impact a firm's optimal project selection policy, including the projects' market potential, the quality of acquired information, the scarcity of resources, and the severity of agency issues. We complement these foundational insights with recommendations on how to provide appropriate incentives during the portfolio construction process.

Keywords: R&D portfolio, external innovation, project selection, information acquisition, incentives